I Wrote Way Too Much About “Capital in the Twenty-First Century”

Thoughts on a Book; Also, Thoughts on Others’ Thoughts on Same

The following is not a summary of Capital in the Twenty-First Century. Either you have read the book, in which case you do not need it summarized; or you have read a sufficient quantity of the responses of others that you do not need it summarized; or else you are probably not the audience for this thing.

The following is not a review of Capital in the Twenty-First Century, at least not in the most straightforward sense. What follows is more of a series of semi-connected responses, musings, and provocations inspired by what is inarguably an important book — a book whose methods, conclusions, and reception will change the way lots of people think and act.

When I last wrote about C21 I wrote about a third key ratio, the first two being Piketty’s alpha and beta, the capital income/national income ratio and the capital stock/national income ratio. What I wrote about was the “capital perpetuation rate,” which is the share of capital income that needed to be saved in order for fortunes to keep pace with economic growth. That rate turned out to be equivalent to g/r, the growth rate of national income/the rate of return to capital. I’m going to start where I left off, but this time with a little less math.

In the spirit of “a little less math,” I won’t provide all the algebra I used to derive a fourth constant, or the spreadsheet I used as a practical check; you can trust me, or I can put it up on my blog or something later. That fourth constant is the rate of wealth inequality perpetuation; it’s the share of capital income that has to be saved for existing capital to keep pace with the overall capital stock. As it happens, that rate is, given certain assumptions, equivalent to the third constant; that is, it’s equivalent to g/r (which is also equal to the ratio of the savings rate to the capital share of national income).

This is important for two reasons — the first in its prima facie conclusion, the second for putting more focus on those assumptions. The first, I think, should be relatively obvious — that the greater the gap between r and g, the easier it is for existing wealth to self-perpetuate, relative to the overall size of the economy and the capital stock.

There are two major parameters that underpin that analysis, however: minimal exogeneity and capital self-perpetuation. (To some extent there’s also an assumption about capital homogeneity; Piketty discusses that, though, and in facts points out that to the degree that returns are heterogenous, higher average returns flow to larger existing concentrations, which buttresses rather than deflates the concerns he raises. More on that later.) I discussed these to differing extents in the same post I linked to above, but their importance means they should be discussed over and over again, especially because challenging those assumptions, especially the first one, is at the heart of a lot of the criticism of C21, and almost all of the thoughtful criticism. Just take a look at Tyler Cowen’s summary of his critique of Piketty:

Overall, the main argument is based on two (false) claims. First, that capital returns will be high and non-diminishing, relative to other factors, and sufficiently certain to support the r > g story as a dominant account of economic history looking forward. Second, that this can happen without significant increases in real wages.

So let’s grapple with this one empirically, which we can do because Piketty has made his data available freely online in a way that has only really just begun to be exploited. Indeed, just mentioning that having a per-capita real-wealth dataset would be nice to Piketty’s (under-credited) partner Gabriel Zucman elicited this response:


Sweet! Zucman, in general, deserves a ton of credit — especially because his data repository is even better than Piketty’s. I haven’t even begun to fully exploit it yet (though you can see some posts using it here and here.

Without doing too much data-crunching here, a quick look at a key question of exogeneity: does r decrease as beta increases? That is, do the returns to capital decline as capital becomes more plentiful?

The answer to that question, as it happens, is yes:

That’s the relationship between r — after taxes — and the country prior-year beta. The decline is clear: high average returns, it seems, are only possible in a low-capital world, and lower average returns become the norm as capital increases.

But Piketty never claims the price effect was zero — just that the volume effect overwhelms the price effect because the elasticity of substitution between capital and labor is > 1. Check out Piketty and Zucman’s paper, which in a way is a very concise version of C21 for an economist audience. On Pg. 33, it’s right there.

And indeed, without too much statistical whizbangery, you can calculate the correlation between capital stock and returns for the existing data:

For those who don’t speak Stata, the key number is the one on the table under “Coef.” along the L1.b line — that’s the one that shows the estimated linear relationship between increasing capital and decreasing returns. It’s roughly -0.007, which means that, in general, every time capital increases by 100% of national income, the expected average return to capital decreases by less than one percentage point — which means that a society that doubles its beta from 300% to 600% would see an initial r of around 5% decline to around 3% — lower, but still enough to increase the capital share of income from 15% of national income to 18% of pre-tax national income, and, assuming a total average tax rate of 40%, pre-tax capital share of income from 25% to 30%.

Yet even that number probably underestimates the resilience of returns for two reasons. Firstly, I used after-tax returns on capital, to capture the actual returns captured by capital; yet pre-tax returns are by definition higher, and if capital levels are endogenous with capital or capital income taxes, then “true” returns could be even more resilient then the after-tax rate would imply. And secondly, if you look at the actual graph, it doesn’t appear to be a linear relationship — it seems that a broad but definitely higher range of average returns at low levels of returns converge on a narrower and, on average, definitively lower range of returns, but one that appears quite steady, especially as beta exceeds ~400%. The average post-tax return to capital in societies whose beta exceed 600% has still been 3.7%.

If anything has been most frustrating about the debate about 21C, it’s been that there has been too little actual “clash” (to use a debater term of art) between those who cry “endogeneity!” and those who cry “empiricism!” This post is not necessarily that clash, but it is an encouragement to more detailed and engaged theories and models about why capital returns may not decline in proportion to capital volume on the one side, and more grappling with the record on the other.

It’s the capital self-perpetuation parameter that I find most intriguing. To get Piketty’s results, you have to assume that capital income is being devoted to savings at a sufficient rate to perpetuate itself, as Zucman once again points out very clearly:


(Note that this is basically just a very concise way of summarizing all the more computationally dense and verbose deriving of the same result above and in the linked post. That’s why he’s Garbriel Zucman and I’m not, and also why this thing is like 8000 words long.)

In the narrowest sense, however, this assumption is obviously false — individual fortunes are made and lost all the time, and though Piketty asserts that a larger share of the world’s ultra-rich are heirs prominent lists of that class imply, it’s also clear that even looking back more anecdotally to the times preceding Piketty’s detailed data to the world of the Middle Ages, with no growth and feudal economies, noble houses would still rise or implode even as capital constancy was at its highest.

Yet in a larger and more interesting sense, there is a more productive way to examine that assumption, a perspective that I think is lurking throughout Piketty’s book — and that’s capital agency.

The biggest meta-insight Dawkin’s The Selfish Gene crystalized was that of looking at anthropological systems from non-anthropocentric perspectives, and assigning unit-of-analysis status and model agency to non-human agents within those systems. The gene, obviously, but also now-notoriously the meme, an idea that still persists in some sense in the way the word is used today, with memes going viral on the internet, implying that humans and their systems are hosts for creatures who compete to perpetuate themselves.

In a way, C21 can be understood as a study not of humans and their economies per se, but of capital itself as something in-and-of-itself with effective agency, a class of artificial organism that for all intents and purposes seeks certain goals through human hosts. That goal is fundamentally perpetuation, and by extension growth, but that implies a certain dynamic in how capital interacts with its human hosts — it will tend to flow over time to higher returns and higher rates of auto-perpetuation. Given that capital tends to achieve both in higher concentrations, capital itself inherently desires concentration to the extent we wish to anthropomorphize it. Almost like evolution, capital selects for concentration — which doesn’t mean merit, of course, and could even in some ways mean its opposite. Private equity is many things, but from the perspective of capital hoping to agglomerate with other capital it is a wonderful technology. Note that this regards capital ownership — in terms of capital location, it likes to find low-capital environments where returns are high, so long as as few individuals or institutions possess the bulk of it.

Is this the “right” way to read 21C? Eh, maybe not. But it is an interesting one, and perhaps a fruitful one, if only for feeding the imagination, and one I’ll return to at the veeeery end of this essay.

The easiest way to think about how this all works is in a world where g=0, and yet still I see people not put this together right, so let’s take a look.

In the most simple gross (not net) production function, Y = f(ALK). Therefore, if Y(t1) = Y(t2) = …, then the output of f(ALK) isn’t varying over time. Though there are many reasons this might be, the clearest one is to assume that all the inputs and form factors — A, L, K, and the various elasticities — are all constant.

What does that mean? The first two factors we can move through quickly — population growth is zero, and productivity growth (whatever that means) is also zero. Capital growth is also zero, but importantly, this doesn’t mean no new capital is being created — it simply means savings net of depreciation is zero, which means that gross capital creation = gross capital destruction. But just because this is true of the whole ecosystem doesn’t mean this is true at every locality — it is entirely possible, for example, for a rich man to go broke or a poor man to save his way to wealth, at least in theory.

In this no-growth world, we can assume that capital has some return, as it always has had throughout history even when there was no expectation of overall growth. If the net capital stock is effectively fixed because gross savings equals depreciation, but the return to capital exceeds its rate of depreciation, it is obviously possible for any one entity to increase their share of that fixed stock of capital over time. It just involves saving a high share of capital income. It is also possible for someone to save out of labor income, of course, but once one has accumulated any capital, it becomes easier to reinvest those returns. And the more capital you have it becomes easier and easier. If your portfolio is $50,000 and returns are 5% or less, you can hope for $2,500 a year, an amount that probably keeps you reliant on labor income, but an amount that can nonetheless be reinvested. If your portfolio is $50,000,000, however, you can reinvest $2 million and still live off $500,000 every year, if you’re “prudent” (a term of convenience, not to be understood pejoratively).

But of course some people are not so prudent, even those that for one reason or another have accumulated large capital holdings. This is, of course, a common story — talented phenom from no wealth strikes it big, then loses it all, a story we hear in industries that especially reward exceptional natural talent (entertainment, sports) or early-adoption (new technology industries). In the end, though, the ‘prudent’ win out, and the already-capitalized prudent win out the most. This is why r>g is so important — if there is any return at all in our no-growth world example, increasing capital concentration means fewer and fewer people consuming more and more of the fixed pie. The extrapolation from there to a world where there is growth is not that difficult — if capital returns exceed growth, then increased capital concentration will still lead to fewer and fewer people gaining at the expense of the many. The key conclusion is that it takes very minimal, very plausible assumptions to create a model that leads to intense wealth concentration.

This is a little why I think Ryan Decker’s critique of Piketty — that “[h]e does not have a model” — is in the end unfair though not inaccurate. Not inaccurate because he does not, of course, fully-specify a formal model, something that he comes much closer to doing his academic papers but still doesn’t quite do. Unfair, though, not only because this is a book aimed at a much broader audience then the academy (there are plenty of books written by fine social scientists that don’t specify models) but because he is instead making the following arguments.

  1. Historically, the data leads to certain stylized facts.
  2. From those stylized facts we can draw certain parameters — not models but boundaries.
  3. The overwhelming majority of plausible models that can be constructed within those bounds converge on a certain result — in this case, intense concentration of income and wealth.

Essentially, the failure of many of Piketty’s critics (note that Decker is not one of them though I’ve just transitioned from his critique) is that they fail to actually challenge any of these precepts, none of which are unassailable.

As has already become clear, one of the most vital parts of Piketty’s whole model (and yes, he does have a model) is depreciation, yet precisely because its invisible — and also, maybe, because the very notion of discussing depreciation makes people want to yawn — it has also gone quite under-discussed (though not uniformly). So let’s change that.

Everything — everything — in Piketty’s model is net-of-depreciation. This is absolutely not how we usually think of these things when we talk about them normally. Piketty’s “national income” measure is not GDP — after subtracting depreciation, it’s often 10-20% less than the parallel GDP figure. The same goes for capital income, the savings rate, the growth rate, and yes, even r.

The first thing this does is make the model, at least initially, radically simpler. Net of depreciation means no depreciation in all of your calculations!

The second thing it does is it makes you think long and hard about depreciation.

Depreciation, of course, is the natural, inexorable disintegration of value. It is horrifying and beautiful and most of all, it is life. It is the key force that leads traditional two-factor macroeconomic models to stagnate in the absence of TFP growth. And more narrowly in this context, it can help piece together more of the narrative…maybe.

Mathematically speaking, the capital share of income cannot exceed national income, and therefore 100%; ergo, the returns to capital must, at some point, decline, or the quantity of capital stagnate, or both. Depreciation suggests a mechanism for that, as a more-capitalized society should have higher overall levels of depreciation, and that should cap net savings in a way that caps the capital/income ratio. But keep in mind that everything in Piketty’s model is net, including national income and economic growth, which should mean that more capitalized societies will, ceteris paribus, grow slower, assuming more capital means more depreciation.

And indeed, there does seem to be a negative relationship between depreciation and savings:

The relationship between capital and depreciation, historically, is also pretty clear:

(That trend-deyfing cluster in the bottom-right with high capital and low depreciation are all data points from Belle Epoque France; why, I couldn’t rightly say)

Depreciation is the great systemic regulator — absent productivity/technology growth, depreciation is an absolute limit on our ability to accumulate capital ad infinitum.

Or is it? Depreciation is a law of the physical world, and therefore a limit on the accumulation of physical capital, which many people intensely associate with “capital” in their minds. But it is extremely important not to do so in this context, as Piketty uses capital synonymously with all wealth. And the nature of capital itself is changing:

The starkness of the change is even clearer in Europe, where agricultural land was much more valuable and slavery had already been abolished. Even in the United States, though, the vast increase in non-land/housing capital is plenty clear. But I am willing to bet that even within that category, the nature of capital is changing.

Imagine ten people who write software. Each of them individually writes little apps that people play on their phones, and they end up making a tidy $100,000/year. Nicely done.

But an eleventh person enters the picture, with a vision of a larger and more complex app that could do amazing things. Person Eleven offers the other ten $200,000 each for a year to create this app; they do so, and in the end the app creates a present value to its creator of $3-4 million — the equivalent of a $100,000 perpetuity with a discount rate of 3-4%, ie endless annual returns of 5% on the initial $2 million investment. We now have doubled labor income, but we also have created capital income where before there was none. And we did so without really any investment in “physical capital” at all — not even desks or computers.

In an important and quite under-discussed passage (one even the author suggests readers can skip due to technical density) Piketty discusses “Tobin’s Q,” or what investors call the price-to-book ratio — the ratio between the stock market capitalization of a firm (the sum market price of all equity in the firm) and the book value of a firm (the sum market price of all the assets on its books).

Yet this section is actually crucially important, if for no other reason that it highlights where many readers (or at least critics) have confused themselves in discussing Piketty’s concept of capital. You see, Tobin’s Q is going up, a lot, everywhere:

Doug Short, focusing on the United States, updates monthly a historical series dating back to 1900, which while differing somewhat from Piketty’s in the specifics, matches the general trend and also shows just how crazy this most recent run-up is:

What does this mean? It means that the focus on capital as stuff is fundamentally off-base — capital, at least as defined by Piketty, is at least to some degree detached from stuff.

This makes more sense when you look at the Q-ratio of many of today’s most valuable firms: as of this writing, Apple is 4.51, Google is 4.09, Facebook is 9.89, Twitter is 7.82, Netflix is 17.85, Amazon is 14.44; shoot, even Microsoft is 3.94. These are all vastly above not just the current national average but the highest the national average has ever been, and by an astonishing amount. The total market capitalization of these seven firms alone is over $1.6 trillion dollars, which means they alone are equivalent to somewhere between 2-3% of all private wealth in the United States. This is even though their combined book value is only ~$325-330 billion, meaning that they have a collective Tobin’s Q approaching 5; put another way, ~ $1.3 trillion dollars of recorded wealth is dependent on some sort of alchemical process by which these companies multiply the value of their inputs.

Just to compare, here’s the price/book ratio of some major financial firms, courtesy of Forbes:

Exxon Mobil has a Q of 2.5; Berkshire-Hathaway is 1.38; GE is 2.05; Walmart, 3.35; Johnson & Johnson, 3.83; Chevron, 1.63; Novartis, 3.15; P&G, 3.19. These are all substantial valuations — investors believe these companies are worth more than the sum of their parts, which is good! But investors believe that these tech companies, which have rapidly become a vast part of the economy, are worth way, way more than the sum of their parts.

It’s not hard to imagine this trend continuing, either — as firms like Uber and Airbnb unlock dead capital, or valuable new services arise thriving on modern technologies, it is entirely possible to imagine the composition of capital itself changing substantially — and specifically, one of these changes may be to lower the capital-depreciation level. If there is less and less correlation between the economy’s measured wealth and the economy’s physical accumulated capital, it is entirely possible to imagine a future with a much higher captial-income ratio than we’ve seen in the past.

A puzzle — troubled law firm-lobbying titan Patton Boggs just merged with another law firm, Squire Sanders. Patton Boggs had been in trouble in recent years, and would probably have gone under without this merger. Some attorneys had to leave the merged firm due to client conflicts.

The question — why did this happen? Why would anyone merge with a law firm? Why not just hire their most talented lawyers and poach their most valuable clients? What is a law firm, other than lawyers and clients and office supplies? What is the capital, the equity, that Squire Sanders wanted to acquire from Patton Boggs?

Among the many received wisdoms 21C might lead us to question, one is the certainty among a broad class of analysts that subsidizing homeownership is something between “a bad idea” and “self-evidently dumb.” You know, like here. Or here. Or here. Or here. Most recently, here and here. Why shouldn’t we all just pocket the subsidies as lower taxes? If that means less homeownership, well, more people will rent. We can make sure the tax cuts are progressive. Wouldn’t that be more efficient?

Some perspective: in 2010, owner-occupied housing generated $1,228.7 billion in imputed income to owners. Less $292.6 billion in depreciation, that’s $936.1 billion in income. As a share of national income, that’s 7.3%. Which is to say 7.3% of our national income was income homeowners received from their home. And what kind of return is that on the capitalization of the housing?

Well I’ll be damned if that doesn’t look a lot like Piketty’s 4-5%.

A little more context — the gross value of owner-occupied housing (before subtracting mortgage debt) was, in 2010, roughly 31-32% of national capital.

Without justifying any particular program, and certainly not the curious mix of regressivity and debt-centrism of many of the US’s homeownership subsidies, a general aim to put this much wealth in the hands of the many, rather than the few, should not be dismissed.

This can, of course, lead us into a long discussion of debt. Because, of course, when you get right down to it, as defined by Piketty, all wealth is debt.

OK, this isn’t exactly true, but it’s close enough to true to be important. As defined here, capital owned by people (which is the only capital, in the end, we care about, and, in the end, all capital is owned by people, otherwise it’s not capital) consists of two things: stuff and paper. Importantly, even stuff is still mediated through paper — you homeowners have title insurance, right?

In the end, regardless of what the “underlying” driver of the value of the capital is, all capital is paper — legally/politically-structured claims on things and institutions. These claims tend to take two forms — equity and debt. Now, there’s a lot of equity out there But what is equity? In a key sense, it’s not that different than debt — it’s a piece of paper that entitles you to make certain claims on an institution. Unlike debt, though, it trades off guaranteed or definitive returns for ownership — that is, some say in what it is the institution does.

What I don’t want to do here, though, is get into a long discussion of debt. As it happens, I’m currently reading or have just finished reading Graeber’s Debt, Mian & Sufi’s House of Debt, and Calomiris & Haber’s Fragile by Design; therefore, I will probably have much to say on the subject of debt and capital in the future. Let’s leave here, though, with the insight that all these claims are, on a fundamental level, determined by legal and political systems that are mutable by humans. They are not laws of nature.

This is most clear in Piketty’s discussion of “Rhenish capitalism,” specifically in the curious phenomenon of the relatively-low levels of German capital relative to income. He notes, however, that this discrepancy vanishes when you compare book value instead of market value of capital, and therefore that this is overwhelmingly a Tobin’s Q issue — remember that chart from above?

Look at purple Germany, well below western Europe and North America.

Piketty explains that, essentially, German corporations are less able to “efficiently” convert raw inputs into capital because of the systematically unique legal and political institutions that govern how corporations operate; specifically, that corporations are mandatorily co-owned by non-profit seeking “stakeholders” that may wish to extract value from the corporation’s activities in ways distinct from pecuniary returns on their capital.

I’m far from an expert on German law, politics, and finance, so without commenting further on the particulars, let this suffice to say that there are plenty of ways to legally and politically govern capital in ways other than the United States does now that still clearly preserve the fundamental underpinnings of capitalism as commonly understood.

Land, in fact, may be the key to explaining why the returns to capital decline much more slowly than models with traditional assumptions would predict. If you confuse “capital” as Piketty defines it with “machines,” even subconsciously, this would make much less sense.

Think about computing power, a form of capital. Clearly, as the quantity and quality of computer processing power has skyrocketed, the economic returns to a unit of computer processing power has declined in equal proportion. Yet that hasn’t dampened the return to land on which computing-centric industries are based; quite the contrary.

Land, then, is the ultimate scarcity, and the one that when both labor and non-land capital are plentiful should quick rise in price as the most valuable land has few substitutes. This matters a lot — land (discounting structures) is a large share of national capital:

It’s entirely possible that land specifically is the key factor behind many of Piketty’s broader conclusions about capital; Karl Smith wrote about this earlier this year as well. The irony of this, of course, is that the key conclusions and predictions of a book that deliberately echoes Marx may be driven by factors that echo his own intellectual forefather — David Ricardo. In that way, C21 can be seen as a bit of both an acknowledgment and a riposte to Samuelson’s famous dismissal of Marx as “a minor post-Ricardian.” Ashok Rao wrote about “the return of Ricardo” last year — maybe a better title for Piketty’s book could have been “Ricardo in the 21st Century.”

Oh, and one last thing — land doesn’t depreciate.

Piketty has written a long, complex, intricate, and thorough book; and yet, somehow, he stumbled into a last-chapter problem of the ages. Without belaboring the points made by others, I’ll tackle the “what is to be done” question a little bit here.

Firstly, Piketty hugely undersells the potential upside of large sovereign wealth funds. Logistically, it would be a trivial issue for developed countries to simply raise taxes by, say, 2-3% of national income for 20-30 years with 100% reinvestment over that period, and then once you’ve got a fund that has, say, 50-100% of national income (or, say, 10-20% of national wealth) you can start scaling down reinvestment and then decide what to do with the excess income — defray taxes? Boost pensions? Invest in public infrastructure? The possibilities are boundless, but if the future is capital, the public future should definitely have an eye on public capital.

Secondly, Piketty ignores a key failing of his wealth tax. Even if it were implemented to his heart’s desires, taxing capital at X% (essentially, the equivalent of taxing capital income at 20*X%) still leaves the capital itself in the hands of the few. I’m not inclined, generally, to knock people for not writing the book I wanted them to write — Piketty wrote a book about inequality of income, which is largely a story about the power of commanding the goods and services produced by societies as economic entities. But I do think it’s somewhat to the detriment of his overall narrative that he mostly (though not wholly) declines to address the question of the social power of capital ownership. In a society where a handful of people control most of the wealth, even if that wealth is taxed at just-below-confiscatory rates, they still own most of the wealth. That gives them tremendous authority, first-and-foremost over the workplace, but also over politics and the media, and by extension an outsized role in dictating mores, norms, and values. A global wealth tax doesn’t fundamentally address the question of the larger human ills that extremely high levels of wealth concentration can imply.

This is what makes Hobby Lobby so insidious in the long term, above and beyond the short-and-medium term harms it will impose on women (some, but not all, of which should be addressed by other government interventions). Think about it this way — broad-based public financial exchanges thrive in proportion to the degree that wealth is (relatively) equally distributed. If someone founds a company that then grows massively, and prefers to diversify their now-large net wealth as opposed to maintain control of their company, they need to find some way to sell something worth tens or hundreds of millions of dollars or even billions of dollars. If very few people have close to that much money, you go public — you find many small buyers that add up to a large buyer. Yet if wealth concentrates, it will be easier for a company’s founder to cash out to, say, three people as opposed to three hundred thousand. We should therefore predict that, as wealth concentration increases, more and more corporate equity and corporate debt will be “closely held” — and as pro-capital courts continue to blur the lines between social and economic power, the few holders of large wealth will have more and more power over the lives of workers regardless of how much of the income generated from that wealth is redistributed.

Lastly, one can’t help but indulge the suspicion that Piketty, whose collection, aggregation, curation, and analysis of an astonishing volume of data is the keystone of his achievement, is perhaps looking at the procedural benefits of a wealth tax a little myopically. Certainly, regularizing and institutionalizing much larger and more detailed data collection and publication functions in the hands of much more well-funded and more-powerful entities than Piketty and his Economist Superfriends would be grand; but it is not itself a reason to prefer one policy solution over another. National wealth accounting and data collection on hyperdrive would be a boon to human knowledge and an invaluable good for present and future generations; but we should therefore do it for its own sake, and independently decide how to address income and wealth concentration. I suspect that Piketty’s years-long quest for information has led him, at least a bit, to conflate means and ends.

So let me just stick in my own policy proposal here — we should build a massive sovereign wealth fund, with initial capitalization over a couple decades by a special capital income/capital gains tax, with the dedicated purpose of being the perpetual endowment of a national university system, one in which tuition would be free or at most nominal.

Why this purpose? A few reasons. Firstly, state public universities have proven themselves too vulnerable to economic shocks and shortsighted local pols. Secondly, I am extremely skeptical of the potential of MOOCs to radically change education (I’ll probably write , and would like to see a large countermove. But thirdly, and most importantly, this would greatly help reduce income inequality in a key way.

Note that this is not via a mechanism whereby marginal increases in degree attainments increase incomes linearly; I agree wholeheartedly with Matt Bruenig’s take on this. What it would do is evaporate the student debt industry, which is key for two reasons.

Firstly, it is key to understand that Piketty’s measures of individual wealth are net of debt — that is, if I buy a $500,000 house with a $100,000 down payment, my net wealth doesn’t increase by $400,000 — it increases, at least at first, by $0. Then, as I pay down the mortgage and the house rises in real value (if it does) then my net worth begins to increase slightly. Therefore, the over $1 trillion in outstanding student loan debt is negative capital to the debtors. Even if you have $10-15,000 in savings earning a return, if you owe that much or more in student loan debt you, at least for the moment, have a net worth of zero — or less.

Secondly, that debt is an asset to your creditor. That trillion-plus dollars in student debt was, until recently largely owned by major financial institutions (this data is old and only represents a portion of the market); their stockholders are richer because they are loaning money to students at interest. That much more new student debt is publicly only increases the absurdity of the entire enterprise. The increasing indebtedness of American households, while not discussed at length by Piketty, is almost certainly a major driver of wealth inequality. A free (or all-but-free), national, top-tier university system would alleviate a major driver of increasing indebtedness and hopefully reverse the un-doing of what Piketty calls the “patrimonial middle class.”

Since Piketty’s book has been a jumping-off point for any number of tangents and digressions, why not discuss Modigliani-Miller? And mostly because of this:


Why not discuss it’s connection to 21C in the context of a distillery?

Two young women, Katrina and Linah, each decide to start a distillery. Katrina, deep-pocketed, decides to simply plow a share (though only a moderate plurality) of her substantial wealth into the venture; Linah, entrepreneurial but empty of pockets, secures a loan.

Katrina and Linah are both well aware that aged bourbon sells at multiples of the price of the un-aged equivalent, as well as confers a less tangible prestige on the brand that build long-term value in a concern. Linah, however, must make regular payments to the bank, and therefore has little choice but to sell most of the product to meet operating costs, and therefore will have a much longer path towards building the reinvestable income necessary to capitalize the aged product that really generates the big profit. Therefore, Katrina, who started richer, ends even more richer than Linah, even if they are both equally good at all aspects of owning and running a distillery. Modigliani-Miller, then, is most interesting (like many economic theories) because it highlights the gap between the assumptions that would make it true and the reality in which it is not.

This may seem like a peculiar case, but in fact, it’s really not. Piketty discusses the many reasons that larger pools of capital tend generate above-mean returns; among them may be that equity creditors, especially larger equity creditors, have a higher tolerance for deferred returns than debt creditors (see also this great paper on why the financial structure of short-selling privileges equity over debt — or just Noah Smith’s summary of it). This is also, essentially, the dynamic that makes venture capital work for all involved, as Marc Andreesen concisely explained to Russ Roberts on EconTalk. The irony, of course, is that Andreesen himself, who has been quite engaged in constructively criticizing Piketty on Twitter, doesn’t quite see it:


This helpfully gets at two things I want to move on to discussing more briefly. The first is that it’s important to note that Piketty is discussing average returns when he talks about r tending to be 4-5%, which means individual investments can entail all kinds of risk and uncertainy. Andreesen notes that 4000 firms, give or take, seek venture capital each year; if you had a billion dollars and gave each of them a quarter-million, you’d probably make your money back even if most of them go bust. In fact, the key heuristic of venture capital is essentially that, if you invest roughly equal amounts into N firms, you only need one of them to generate N*100% returns to break even, and the rest is profit. But tying up vast amounts of capital in individually highly risky and uncertain not to mention almost totally illiquid firms with no liquid capital to speak of is just something most individuals, or even small groups of individuals, simply cannot maintain; but it works excellently for those who can access exceptional wealth. And you can’t do it with debt, which among other things is one of the ways that people with little present capital can make large investments — housing, education, business formation — that can unlock economic opportunity. But the power of leverage to build rungs on the economic ladder is limited relative to the power of existing capital to self-replicate.

Another thing Andreesen touches on when he discusses the work of professional investment is the somewhat soft boundary between capital and labor. Piketty notes two things independently that I think are considered productively in tandem:

  1. Not all accounting returns to capital are true returns to capital; a decent portion of them are the returns to labor necessary to maintain a productive capital portfolio.
  2. Contrary to historical trends, a substantial share of the recent surge in overall income inequality was driven by returns to labor, not capital, largely explained by the “supermanager” phenomenon of top-tier executives at large firms with enormous salaries.

This raises the question, for me at least, of whether or not some of the accounting returns to labor aren’t, in fact, a kind of return to capital. The enormous compensation of top-tier executives strikes me as sort of an unwritten, informal bargain between the “true” owners and the supermanagers — the latter can essentially lay claim to a very substantial share of their firms’ profits in exchange for not having well-defined proprietary rights to those profits (of course, a decent share of the labor income of these supermanagers is in equity, not cash). That is, so long as the firm is performing and shareholders are making decent returns, top execs can essentially fill a burlap sack with Salmon P. Chases as long as the board can shut off the faucet and/or hit the eject button the moment things go southerly. If you look at vast “supermanager” incomes as essentially a kind of ad-hoc return to capital, it fits more neatly into Piketty’s broader narrative.

In the long run (and yes this means this piece is almost over, so feel free to crack that beer) the most important accomplishment of Piketty may be less in his message than his means. Whether income inequality persists as a thorn in the side, or even a fundamental weakness, of Western democratic capitalism as currently practiced depends on all kinds of uncertainties that don’t really require fleshing out here. But Piketty’s book is both a loud, obvious signal of trends in the interactions of the social sciences, politics, culture, and technology, as well as a likely catalyst of those trends.

The first major trend is, in some ways, both a progressive and a regressive trend. Piketty’s book is vitally dependent on the data carefully accumulated, standardized, harmonized, and analyzed by Piketty and his co-authors. What it is not dependent on, however, is the ultra-computationally-intensive statistical analyses or complex and opaque mathematical models that have become de rigueur in economics. It is instead defined by a focus on carefully establishing stylized facts and knitting those facts into a narrative, one that can be easily understood and digested by many people with no training in economics while still requiring the discipline, insight, accumulated knowledge, and expertise of an economist.

The second major trend is a move away from economics as an abstract discipline independent of politics and political science and towards a bold reclaiming of the banner of political economy. If anything summarizes many of the best recent books about economics — C21, Fragile by Design, House of Debt, Debt — not to mention the best recent blogging about economics, is that they are as much about politics as they are economics. After a financial crisis driven by things like “the Gaussian copula function” and “physics graduates hired by big banks” there finally seems to be a substantial backlash within the economics community against the pernicious idea that economics is something independent of politics.

The third major trend, the one that has been ongoing the longest, is that of social scientists in general and economists in particular bypassing gatekeepers to communicate with the public at large (or at least a much broader segment of the educated elite). Of course Paul Krugman receives substantial credit for pioneering this, as does Tyler Cowen, but it is clear over the last decade that more and more practicioners in the economics field are seeking to leverage their work by directly influencing a broader class of people rather than winning over allies in the academy.

What is important about all of these trends in combination in excess of their importance individually is that they represent specifically in C21 a loud, booming shot against the bow of Economics, the closest thing we have today to a global state religion. Allow me to immediately clarify that I deliberately capitalized “Economics” so at to distinguish it from “economics,” which is a vibrant and useful academic discipline and social science. Capital-E Economics is a rigid dogma, complete with unchallengeable precepts and inscrutable texts whose minutiae are debated vigorously by devoted inner-circle keepers of the flame, that has stifled public debate about innumerable issues of overwhelming importance since the end of the Cold War. It’s results as public policy are mixed at best and as often as not deleterious, and whose general effect (if only rarely its explicit purpose) is to justify the increasing concentration of wealth and income and the increasing social and political power of those who receive it.

It’s apotheosis may be the bizarre moment in October 2008 where Alan Greenspan confessed to finding “a flaw” in his ideology, which despite not knowing “how significant or permanent it is” he nevertheless found “distressing.” This, of course, as the global economy was in rapid, disastrous implosion of a scale not seen in generations. The whole thing reads like a baffling oddity out of the Middle Ages, inscrutable to moderns.

The usefulness of Piketty’s book, even more than anything before it, is that it represents a stern challenge to not just the beliefs of Economics but also its style, conventions, and methods — and all done by an economist, one in very good standing. Nothing about Piketty is heterodox — indeed, the fact that those who disagree with the central conclusions of Economics are termed “heterodox” should tell us all we need to know.

It will take more people like Piketty willing to challenge the way Economics currently works, not just from the digital soapbox but from the lecture hall and the university press, to save economics — or at the very least, save enough of it that we can have a vibrant discipline of political economy. Because that as much as anything is the desperately-needed intellectual edifice needed to grapple with the challenges the 21st Century will bring.

Sort of oddly, the way I want to end this piece came together after reading Calomiris & Haber’s Fragile By Design, a book I feel quite comfortable recommending despite being far from on-board with many of its particulars. The passage that most struck me when first reading it — and maybe this is just because it has a certain geoathletic relevance — was the introduction to their chapter on Brazil, which I would like to quote at length:

The second overarching initial condition was that Brazil’s soils and climate were ideal for sugar cultivation, and thus form the sixteenth century onward it was one of the world’s major sugar producers. Sugar has a number of features that predisposed it to being grown on immense plantations with slave labor. If cut sugar cane is left unprocessed for more than 12 hours, the crop is lost to fermentation. Additionally, there are tremendous economies of scale in the milling of cane and the processing of the resulting cane juice into sugar; grinding mills and boilers left idle represent money lost. As a result, there has to be very careful coordination of the harvesting and processing of sugar. The most efficient organization of the production is for the processors to own the plantations where the cane is grown, so that cane can be cut and delivered to the mill at a pace dictated by the machines. That organization of production presents something of a problem from the point of view of managing a labor force: cutting cane with a machete in the tropical sun at a pace determined by immense grinding machines is not just backbreaking, it is soul destroying. The grim solution was to use slaves, organized into gangs, so that the pace of work could be maintained regardless of what happened to backs or souls.

I found this darkly fascinating especially in light of having also just read Graeber’s Debt, a key theme of which was the nexus between state mobilization of force, markets, currencies, and slavery. But I also found it interesting because it encapsulated, for me, what the biggest fear capitalists — and citizens of capitalist societies — should have.

Capitalism is a term that can be notoriously hard to define even as everyone has very strong feelings about it. Define it too broadly, and everyone is capitalist; define it too narrowly, and nobody is. What I would like to do, though, is throw a new term into the mix — capitalocracy.

Let’s remember what’s at stake — Piketty’s data demonstrates that the top 10% of earners have increased their income share from one-third in 1970 to one-half today. National income has tripled in that time, but the population has increased by 50%, which means that the average income of the top 10% has tripled while the average income of the bottom 10% has increased by no more than 50%, and given other data about median wage stagnation in that time, it seems highly likely that those gains were concentrated in the upper segment of “the rest.”

Another way of framing this is that 60% of the growth in aggregate national income over the past forty years has accumulated to the top 10% of the population, and those winnings have disproportionately accumulated within the 10% to the 1%, within the 1% to the 0.1%, and within the 0.1% to the 0.01%. More and more people are becoming more and more detached from experiencing any direct benefit from aggregate economic growth, having to settle for secondary benefits.

This has given rise to concerns that, should current trends continue, we may return to a situation like that of the past where very few people control vast amounts of wealth, and by extension wield the vast majority of social, economic, and political power.

But the precise nature of this society, I think, has been misunderstood. Many people have referred to it as plutocracy, rule by the very rich, which is close, but I’m not sure entirely captures the potential dynamics at play, as (at least for now) there is still some deal of flux within the elite class. Many others have revised feudalism, or proposed the term neo-feudalism, to describe the retrenchment of the extreme privilege of the few. But while this term has resonance, it isn’t exactly correct, at least not until there is a much greater formal fusion between the state and the rich.

Instead, what I fear as our worst-case scenario is a society governed not by the wealthy but by its wealth, in which even the people exercising the overwhelming share of power nonetheless feel constrained by the demands of the capital from which their power flows. It is this dynamic, beginning and the top and trickling down the hierarchy, which leads to environmental despoliation, human degradation, and even absurdities like this. This capitalocracy, in which all of us, even those of us closest to the source, are ruled by the demands of the massive wealth we have accumulated, is the dystopia at our doorstep.